Cameron’s bet on weaker sterling could backfire

Commentary: Triple-dip recession could sink U.K. and its leader

LONDON (MarketWatch) — From Mervyn King, the governor of the Bank of England downwards, British officials in recent months have made no secret of their distaste for the pound moving above €1.20 at a time when the U.K. economy has been in the doldrums.

After sterling’s slide in the wake of disappointing fourth-quarter U.K. growth numbers, and in view of new optimism about the euro, the British government is likely to get what it asks for: a significantly weaker exchange rate in coming months.

Reuters

Britain's Prime Minister David Cameron embarks upon a high-risk strategy.

With sterling down to €1.17
GBPEUR, +0.95%
amid widespread reports that the currency is losing its prized “safe haven” status, the reappraisal of sterling’s fortunes may not all be plain sailing. David Cameron, the prime minister, has already embarked upon a high-risk strategy with his announcement of a possible referendum in 2017 on U.K. membership of the European Union.

Last week his calibrated gamble on Europe enjoyed a better response than many had expected. Europe’s dominant leader, German Chancellor Angela Merkel, refused to condemn Cameron’s move and even awarded his European reform plan some words of cautious approbation.

But the prime minister’s strategy could fall apart if the U.K. economic slowdown turns into a full-scale recession. This could herald a run on the pound and a slide toward parity with the euro
EURUSD, -0.85%
The outcome would be a sharp fall in foreign asset managers’ propensity to buy government bonds, accompanied by a thorough U-turn in the “austerity-first” economic strategy of George Osborne, the chancellor the exchequer (finance minister). This could even bring a leadership challenge before the next general election, due in 2015.

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Friday’s news of a 0.3% fall in Britain’s output — pushing the economy closer to a so-called triple-dip recession — spoiled what had otherwise been a relatively good week for Cameron. By agreeing to demands from his Conservative Party for a plebiscite on U.K. adhesion to the EU, but clothing his call for EU reform with generally pro-European rhetoric, the prime minister accomplished a tricky balancing act. Read Darrell Delamaide on the U.K. drifting away from Europe.

Cameron achieved the difficult feat of neutralizing his domestic adversaries and simultaneously stretching out a constructive hand toward other European leaders. He mapped out a genuine route to a more competitive and (ultimately) prosperous EU better able to cope with the imperatives of globalization.

But the Cameron plan could run into the sand if he is unfortunate enough to be dispossessed before the next election. Boris Johnson, the mayor of London who is Cameron’s most serious potential challenger-in-waiting, confronted Cameron head-on. In a speech in Davos, the swashbuckling London leader called on his rival to “junk talk of austerity” and heavily increase investment in infrastructure.

The only possible route for Johnson to secure the Conservative Party leadership and, in its wake, the mantle of prime ministership lies in widespread disillusionment with the government’s orthodox economic course. Ramping up his activist image, Johnson declared: “We need to invest in the rail and road infrastructure that will get the work force of London and the southeast to their jobs on time: that is crucial to our competitiveness.”

Mervyn King, an earlier devotee of the government’s deficit-cutting strategy, last week underlined his disappointment with the course taken so far, urging the government to take supply-side measures to get the economy going again.

Reuters

London Mayor Boris Johnson dangles in the air at the London Olympics in 2012. He’s still walking on the high wire in Tory politics.

Johnson is an excellent entertainer. Although, for many, he lacks the gravitas for the top job, he could become the confidence-boosting leader of choice if Cameron and Osborne lead the British economy down a dead-end. For Cameron, a nightmare scenario is that the economy bumps along the bottom for several months, and that the atmosphere in the Conservative Party becomes increasingly fraught .

In such circumstances, no amount of careful understanding from Merkel for Cameron’s European proposal could avert the prime minister’s fate. Another spell on the Opposition parliamentary benches would beckon.

If the pound falls too sharply without sparking off an export-led revival, this could be the denouement. British officials must be careful what they wish for. The result they have been urging could turn out more virulent than they had bargained for.

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